Private Equity LBO Modeling Tests: Who gets them? What are they?

Let’s talk a bit about the private equity LBO modeling test. The LBO modeling test is used by many, perhaps most, PE firms both large and small as part of the interview process to test 3 things:

Finance knowledge

Excel modeling skills

Executive presentation / communication skills

This is a short series that covers the “who” and “what” of the LBO modeling test, the specific components of the LBO modeling slide presentation, delivering the oral presentation to your interview committee, how to practice for the LBO modeling test, and how the modeling test is evaluated in the context of other recruiting considerations.

This post is about the “who” and “what” of the LBO modeling test. You can see other posts in this series here:

First thing to clarify is that everyone gets the same modeling test — whether you are coming from a banking, consulting, corporate, or other background.

In this regard, investment banking candidates do have an edge because they most likely already have expert Excel skills and, given the nature of their jobs, they probably have a decent understanding of accounting and finance as well (although you would be surprised how many banking analysts I have met in my day who lack critical reasoning skills when it comes to analyzing businesses).

Consultants do well when it comes to executive communication and synthesis skills, and most of them have pretty good Excel skills too (though not as crazy good as bankers), and many of them even have a decently strong understanding of finance (although this is where they are weakest compared to bankers).

People in corp dev or at Fortune 500s may be somewhere in between, or may lean more one way or the other, depending on their background.

Point is, everyone has to do the LBO modeling test, and there isn’t a shortcut around it, so you should prepare to carve out sufficient time to prep for it diligently if you want to have a shot at doing well.

What should you expect to see in the modeling test as an interview candidate?

Your mission in any LBO modeling test is simply to answer the question: “Should the firm invest in the company you just analyzed?”

The way the modeling test is administered is typically in one of two ways.

The first way is: You may get a memorandum or “bank book” containing financial statements, operational data, market and industry information, and other research materials describing the company, its performance, the industry it sits in, its competitors, suppliers, customers, etc. You will then be given a couple days or a week to analyze the company’s performance, build an LBO model, and create a slide presentation arguing your investment thesis for the company, which you will be asked to present to an investment / hiring committee at the end of the assignment.

The second way is: You may be given similar data and materials and be asked to analyze the company, build an LBO model, and build a slide presentation deck as part of the interview, and then present to the committee immediately afterward before you wrap up your interview. This is particularly common at brand-name, blue chip PE funds and mega-cap PE funds. The amount of time they give you could be as little as 1 hour and as much as 8 hours — it can vary a lot between firms, and even between recruiting years.

Of course, different levels of “resolution” are expected depending on how much time you are given. If they only give you 1 hour, you are obviously not going to be able to develop nearly as sophisticated an analysis as an 8 hour timeframe would allow you, much less a 1-week timeframe.

In terms of research materials you will be given, your PE recruiter will typically give you a “bank book” or a (pseudo) “confidential information memorandum” which may already be highly summarized for you (e.g., less than 10 pages) or it might be unabridged, which could run a couple hundred pages long or more. If you are asked to evaluate a public company, the firm might just ask you to look at the company’s latest 10-K for the data and information you need to conduct your analysis.

Even though you may have a ton of questions for your recruiter about how to scope the assignment or build your model, they will almost never give you any guidance on this because the whole point is that they want to see how good you are at “figuring it out.”

What are you expected to show when you present your findings?

Keep things simple — that’s my biggest piece of advice. Do NOT try to build an overly complex model to show how much you know. Do not try to analyze all the company’s various customer segments for a single product line in the Asia Pacific region. If you get too complex or too detailed, you are much more likely to not finish the assignment within the time provided or screw something up. Either of these is a much bigger sin than being too simplistic in your analysis.

Unless they give you specific guidance on how to structure your presentation, you should structure it with:

2-3 slides showing key points about the market, industry, and most important operational metrics of the company

3 slides showing key outputs from your LBO model (which you will build but not show in its entirety — you will show sources and uses, the income statement, free cash flow / working capital projections, and returns scenarios at various entry and exit multiples / prices, EBITDA projections, and leverage ratios)

One last tip: do NOT cram a bunch of dense text onto your slides. Since you will be delivering an oral presentation as part of the assignment, just jot down bullets for your main points to jog your memory so you can speak to them and transition smoothly when you present orally to the committee.

Andrew Chen received an associate offer, without any formal LBO experience, on his first attempt at applying for private equity investing positions in the competitive San Francisco Bay Area. He worked for Huntsman Gay Global Capital, the Bain Capital spin-out founded by the industrialist Jon Huntsman, former Bain Capital Chairman Bob Gay, former San Francisco 49ers Superbowl quarterback Steve Young, and including former CFO of Citigroup and American Express Gary Crittenden. Andrew was previously a member of the Corporate Finance & Strategy Practice at McKinsey & Company and holds a J.D. from Harvard Law School. You can follow him on Twitter and Google+.

About

Andrew Chen received an associate offer, without any formal finance training, on his first attempt at applying for private equity investing positions in the competitive San Francisco Bay Area. He worked for Huntsman Gay, the Bain Capital spin-out led by the industrialist Jon Huntsman, former Bain Capital Chairman Bob Gay, former San Francisco 49ers Superbowl quarterback Steve Young, and former CFO of Citigroup and American Express Gary Crittenden. You can follow him on LinkedIn, Twitter, and Google+.